Federal Reserve transparency questioned

Central bank’s move could remove, or increase, market uncertainty

By

WarangkanaChomchuen

NEW YORK (MarketWatch) — The Federal Reserve’s decision to publish the interest-rate forecast of its members – a historic move to offer greater transparency – is being met mostly with skepticism by stock analysts.

The Fed on Wednesday followed up on its unexpected plan to maintain short-term rates near zero through late 2014 with the rate predictions of members the central bank’s policy-setting committee.

Of the 17 members, only 10 of whom vote, 11 said they expect the Fed to raise rates by the end of 2014. All together, they expect the Fed to hold rates near zero until late 2014, but not much longer.

Last year, Fed Chairman Ben Bernanke started holding regular news conferences in an ongoing effort to offer additional insight into an entity long viewed as overly secretive.

The Fed’s bid to be more transparent puts it in line with many other central banks around the world and follows steps first taken in the early 1990s when the central bank started announcing the changes in the overnight federal funds rate and delayed transcripts of its deliberations.

But in its attempt to be more transparent, the Fed could be tying its own hands, some market watchers said.

“By defining the target so specifically, the Federal Reserve reduces its ability or flexibility to respond to a combination of inflation and growth,” noted Hugh Johnson, chairman of Hugh Johnson Advisors.

There is a chance that inflation will rise well above Fed’s 2% target while economic growth will remain anemic. “What will the Fed do then? Does it begin to raise rates in the face of economic activity?” asked Johnson.

“The positive would be, the more transparency there is with the Fed, the more opportunity there is for risk takers to take risks” like buying equities, said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

On Wednesday, stocks surged after the Fed said it was likely to keep rates ultralow until late 2014. But the benchmarks gave up early gains Thursday after data showed a surprise drop in new home sales last month.

Certainty in an uncertain situation

Marc Pado, U.S. market strategist at Cantor Fitzgerald, is among those who gives the Fed credit for trying to inject some certainty into a market that for much of last year was subject to wild bursts of volatility.

“One of the things the market is lacking is consistency and certainty. If you know how long it is (for the interest rates to be on hold), then you can act accordingly. That I think was part of the whole transparency move…to offer certainty into an uncertain situation,” said Pado.

But Pado too worries the Fed’s efforts to be more open could backfire and increase the risk of market disruptions, saying the odds of the Fed getting it right are iffy at best, and the chances are reduced by the longer-range forecasts.

Fed’s moves pressures savers

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The Federal Reserve's announcement Wednesday to keep short-term interest rates near zero through 2014 may result in still lower interest rates on bank accounts.

“Most economists get uncomfortable the further out you get,” said Pado, who believes the central bank needs to clarify that its forecasts are based on how they feel today about the future.

The Fed’s transparency is “worthless” if the forecasts are wrong, argues Miller Tabak equity strategist Peter Boockvar, who believes the central bank is engaged in a game of manipulation intended to keep yields artificially low in order to bolster the price of equities and the economy.

The Fed’s “worst call of all time” was when the central bank in 2006 considered the trouble stemming from sub-prime mortgages contained said Boockvar, referring to the risky home mortgages and related financial instruments that led up to the near meltdown of the U.S. financial system.

Bernanke himself sounded a note of caution, telling a news conference after Wednesday’s announcement that he “wouldn’t overstate the Fed’s ability to massively change expectations through its statements.”

In the end, leaving a little room for the market to guess might not be a bad thing.

“The Fed is shedding its mystique,” Johnson said. “They don’t recognize that sometimes less is more.”

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